Insider ownership and the cost of debt capital: Evidence from bank loans

Abstract

Agency theory predicts that the incentives for insiders to extract private benefits at the expense of creditors are negatively related to the level of ownership retained by insiders. However, the ability of insiders to effectively control the resources of the firm and engage in such activities is positively related to their level of ownership. Using a large international sample of bank loans, this paper demonstrates how these two contrasting forces result in an inverse U-shaped relationship between insider ownership and the firm's cost of borrowing. Consistent with the control argument, the positive relationship between insider ownership and cost of debt for low levels of insider ownership is found to be not in place when insiders are entrenched above and beyond their level of ownership. Finally, the relationship between insider ownership and cost of debt in presence of loan contract clauses is addressed.